8/14/2019 Financial Statement Analysis (Fsa)
1/32
FINANCIAL STATEMENT
ANALYSIS (FSA)
FSA is the collective name for the tools &
techniques that are intended to provide
relevant information to decision-makers
(Investors, management, owners,
creditors, government).
Evaluation of past performance & financial
position (trend of past sales, earnings,cash flows, profit margin & ROI).
8/14/2019 Financial Statement Analysis (Fsa)
2/32
STANDARDS OF COMPARISONS
Rule of Thumb Indicators (benchmark
financial ratios); Past performance of the company (over a
period of time) trend analysis;
Industry standards.
8/14/2019 Financial Statement Analysis (Fsa)
3/32
SOURCES OF INFORMATION
Company Reports: (i) Directors Report,(ii) Financial Statements, (iii) Schedules &Notes to Financial Statements, (iv)
Auditors Report. Stock Exchanges: BSE Official Directory &
BSE Library for Annual Reports.
Business Periodicals. Information Services: CMIE, CRISIL,
ICRA, CARE.
8/14/2019 Financial Statement Analysis (Fsa)
4/32
QUALITY OF EARNINGS
Refers to probability of earnings trendscontinuing and the extent to which
earnings could represent distributable
cash.
8/14/2019 Financial Statement Analysis (Fsa)
5/32
May be affected by:
Choice of Accounting Methods & Estimates:
GAAP provides flexibility in determining accountingmethods:
(a) Depreciation: SLM, WDVM, SOYDM.
(b) Inventories: LIFO, FIFO, Weighted Average Cost.
(c) Doubtful Debts: % of Receivables Method, % ofSales Method.
(d) Goodwill: Full Write-off Method, Amortization
Method, Not Write-off Method. Revenue Recognition in Long-Term Contracts: %
Completion Method, Completed Contract Method.
8/14/2019 Financial Statement Analysis (Fsa)
6/32
May be affected by:.contd.
2. Extra-Ordinary Items:
Incomes/Expenses arise from events that are distinctfrom ordinary activities of the business (Not expected torecur regularly).
Decision to treat an item as extra-ordinary affectsoperating earnings:
Write down of inventories to net realizable value;
Write down of fixed assets to recoverable amount;
Restructuring activities if an enterprise; Dispose of Long-term investments;
Litigation Settlement.
8/14/2019 Financial Statement Analysis (Fsa)
7/32
May be affected by: .contd.
3. Prior Period Items:
Incomes/Expenses that arise in thecurrent period as a result of errors or
omissions in the preparation of FinancialStatements of one or more prior periods:
Errors in totaling Inventory Sheets;
Mistakes in computing depreciationamount arising from use of incorrect assetlives or failure to consider residual value.
8/14/2019 Financial Statement Analysis (Fsa)
8/32
May be affected by: .contd.
4. Discontinued Operations:
It is the result of the sale or abandonment of a
separate, major and identifiable line of business. For predicting earnings from regular, on-going
activities, the results of continuing operationsneed to be separated from those of the
discontinued operations.
8/14/2019 Financial Statement Analysis (Fsa)
9/32
May be affected by: .contd.
5. Change in Accounting Policies:
GAAP do not permit an enterprise to change its
accounting policies unless there is adequate
justification for the change. Adequate justification refers that the change is
required by law or any accounting standard or by
an accounting enterprise.
When a change is executed, the fact and effect
of the change on net profit should be disclosed.
8/14/2019 Financial Statement Analysis (Fsa)
10/32
8/14/2019 Financial Statement Analysis (Fsa)
11/32
TECHNIQUES OF FINANCIAL
STATEMENT ANALYSIS
1. HORIZONTAL ANALYSIS:
It is the calculation of amount changes &% changes from the previous year to the
current year.3. TREND ANALYSIS:
Involves the calculation of % changes in
financial statement items for a number ofsuccessive years. It is en extension ofHorizontal Analysis to several years.
8/14/2019 Financial Statement Analysis (Fsa)
12/32
TECHNIQUES OF FINANCIAL
STATEMENT ANALYSIS.contd.
3. VERTICAL ANALYSIS:
It is the proportional expression of each item on
a financial statement to the statement total.
The results of Vertical Analysis are presented in
the form of Common-Size Statements in which
all elements in each statement are expressed inpercentages of some common number & always
add up to 100 percent.
8/14/2019 Financial Statement Analysis (Fsa)
13/32
COMPARATIVE COMMON SIZE
STATEMENTS (VERTICAL ANALYSIS)
Part A: BALANCE SHEET:Particulars 20x1 20x2 20x3 20x4Capital 26 22 32 30Res.& surplus 17 23 19 22
Secured Loans 33 30 28 27Unsec. Loans 6 6 5 5Current Liab. 18 19 16 16Fixed Assets 64 63 64 65Investments 3 2 2 2
Debtors 16 15 16 16Inventories 15 18 17 16Misc. Expenses 2 2 1 1TOTAL 100 100 100 100
8/14/2019 Financial Statement Analysis (Fsa)
14/32
COMPARATIVE COMMON SIZE
STATEMENTS (VERTICAL ANALYSIS)
Part B: INCOME STATEMENTParticulars 20x1 20x2 20x3 20x4Net Sales 100 100 100 100COGS 74 70 73 76
Gross Margin 26 30 27 24Operating Exp. 7 8 7 8Non-Op. Exp/Inc - - 1 1EBIT 19 22 21 17Interest 4 4 4 4PBT 15 18 17 13
Tax 6 8 7 7PAT 9 10 10 6Dividends 4 4 4 4Retained Earnings 5 6 6 2
8/14/2019 Financial Statement Analysis (Fsa)
15/32
TECHNIQUES OF FINANCIAL
STATEMENT ANALYSIS.contd.
4. RATIO ANALYSIS:
Establishes relevant financial relationship
between the components of financial
statements;
These ratios are used to evaluate
profitability, liquidity, activity, solvency
aspects of the business along with its
capital market strength.
8/14/2019 Financial Statement Analysis (Fsa)
16/32
RATIO ANALYSIS
(Liquidity Ratios) LIQUIDITY RATIOS: Refer to the ability of the
firm to meet its obligations in the short-run,usually one year.
Current Ratio: Current Assets Current Liabilities
(C.A. includes cash, marketable securities,debtors, inventories, loans & advances, &
prepaid expenses. C.L. includes loans &advances taken, trade creditors, accruedexpenses & provisions)
8/14/2019 Financial Statement Analysis (Fsa)
17/32
RATIO ANALYSIS
(Liquidity Ratios) .contd.
(b) Acid Test Ratio: Quick Assets
Current Liabilities
Quick assets are current assets excluding
inventories as it is the least liquid C.A.(c) Bank finance to Working Capital Gap Ratio:
Short-term bank borrowings
Working Capital Gap
It shows the dependence on bank finance andthe working capital is equal to C.A. less C.L.other than bank borrowings.
8/14/2019 Financial Statement Analysis (Fsa)
18/32
RATIO ANALYSIS
(Leverage Ratios)2. LEVERAGE RATIOS: Refer to the use of debt finance in
the capital structure.
(a) Debt Equity Ratio: Debt
Equity
It shows the relative contribution of creditors & owners.Numerator consists of Short & Long-term Liabilities &denominator consists of Net Worth plus PreferenceCapital)
* Net Worth = Equity Capital + Reserves &Surplus
Lower the ratio, higher the degree of protection enjoyedby creditors.
8/14/2019 Financial Statement Analysis (Fsa)
19/32
8/14/2019 Financial Statement Analysis (Fsa)
20/32
RATIO ANALYSIS
(Leverage Ratios) .contd.
(d) Fixed Charges Coverage Ratio:
EBIT + Depreciation
Interest + (Repayment of loan/ 1-tax rate)
It measures debt servicing ability as it considersboth the interest & principal repaymentobligations In the denominator, the repayment
of loan is adjusted upwards for the tax factor asloan repayment, unlike interest, is not taxdeductible.
8/14/2019 Financial Statement Analysis (Fsa)
21/32
RATIO ANALYSIS
(Turnover/Activity Ratios)3. TURNOVER / ACTIVITY RATIOS: Are based on the
relationship between the level of activity, representedby COGS & the level of various other assets.
(c) Inventory Turnover Ratio:COGS
Average Inventory
It measures how fast the inventory is moving through
the firm & generating sales - higher the ratio, moreefficient is the management of inventory & vice versa.
8/14/2019 Financial Statement Analysis (Fsa)
22/32
RATIO ANALYSIS
(Turnover Ratios)..contd.
(b) Accounts Receivable Turnover Ratio:
Measures how many times the debtors turn over
during the period.
Net Credit SalesAverage Accounts Receivables*
*If the figure for net credit sales is not available,
one may consider net sales figure.The higher the A/R turnover, the greater the
efficiency of credit management.
8/14/2019 Financial Statement Analysis (Fsa)
23/32
RATIO ANALYSIS
(Turnover Ratios)..contd.
(c) Average collection period: Represents thenumber of days worth of credit sales that islocked in debtors.
Average Accounts Receivable X 365Average daily credit sales
If the figure for credit sales is not available, onemay consider with net sales figure. Average
collection period & the A/R are related in thefollowing way:
Average Collection Period = 365 / A.R. Turnover
8/14/2019 Financial Statement Analysis (Fsa)
24/32
RATIO ANALYSIS
(Turnover Ratios)..contd.
(d) Fixed assets turnover Ratio: Measures sales
per rupee of investment in fixed assets A
higher ratio indicates a high degree of efficiency
in asset utilization.Net SalesAverage Net Fixed Assets
Caution: When fixed assets of a firm are old &substantially depreciated; this ratio tends to be
high as the denominator is low.
8/14/2019 Financial Statement Analysis (Fsa)
25/32
RATIO ANALYSIS
(Profitability Ratios)
4. PROFITABILITY RATIOS: Reflect the
final result of the business operations
(of two types) Profit margin ratios &
Rate of return ratios.
Gross Profit Margin Ratio: Shows the
margin left after meeting manufacturing
costs: Gross Profit
Net Sales
8/14/2019 Financial Statement Analysis (Fsa)
26/32
RATIO ANALYSIS
(Profitability Ratios). Contd.
(b) Net Profit Margin Ratio: Shows the earnings leftfor share holders (both equity & preference) as% of net sales.
Net Profit
Net Sales(c) Return on Equity Ratio: Measures the
profitability of equity funds invested in the firm reflects the productivity of the ownership capital
employed in the firm.Equity Earnings
Average Net Worth
8/14/2019 Financial Statement Analysis (Fsa)
27/32
RATIO ANALYSIS
(Profitability Ratios). Contd.
(d) Return on Total Assets: It is a measure
of capital employment efficiency:Net Income
Average Total AssetsTo ensure internal consistency, following
variant may be employed:
Net Income + InterestAverage Total Assets
8/14/2019 Financial Statement Analysis (Fsa)
28/32
RATIO ANALYSIS
(Profitability Ratios). Contd.
(e) Earning Power: it is a measure ofperformance, which is not affected byinterest charges & tax payments;
it abstracts away the effect of financialstructure & tax rate and focuses onoperating performance.
EBITAverage Total Assets
8/14/2019 Financial Statement Analysis (Fsa)
29/32
RATIO ANALYSIS
(Valuation Ratios)5. VALUATION RATIOS: Indicate how the equity stock of
the firm is assessed in the capital market.
Price-earning Ratio: Commonly referred to as price-
earning multiple is a summary measure, reflectinggrowth prospect, risk characteristics, shareholderorientation, corporate image & degree of liquidity.
Market Price per share (Av. market price)Earning per share {(PAT Preference dIvidend)/ No. ofequity shares)}
8/14/2019 Financial Statement Analysis (Fsa)
30/32
RATIO ANALYSIS
(Valuation Ratios). Contd.
(b) Yield: Measure of the rate of return earned by
the shareholders.Dividend + Price change
Initial PriceMay be split into two parts:Dividend + Price ChangeInitial Price Initial Price
(Dividend Yield) (Capital Gains/ Losses Yield)
Firms with low growth prospects offer a high
dividend yield and a low capital gains yield.
8/14/2019 Financial Statement Analysis (Fsa)
31/32
RATIO ANALYSIS
(Valuation Ratios). Contd.
(c) Market Value to Book Value Ratio: reflects the
contribution of the firm to the wealth of the
society.
A ratio >1indicates that firm has created wealth.If the ratio is 2 , it indicates that firm has created
a wealth of one rupee for every rupee invested
in it.
Market Value Per Share
Book Value Per Share
8/14/2019 Financial Statement Analysis (Fsa)
32/32
RATIO ANALYSIS
(Valuation Ratios). Contd.
(d) Tobins q orq Ratio: Proposed by James
Tobin, the ratio identifies the ratio of market
value of a firms securities to the replacement
cost of its physical (non-financial) assets:Market value of equity & liabilities
Estimated replacement cost of the assets
Firms will have incentive to invest, when q >1and will be reluctant to invest once q becomes
equal to 1.
Top Related